The Role of Utmost Good Faith in Insurance Law - Case Study Example

Material Fact - The Role of Utmost Good Faith in Insurance Law: Insurance law is based upon the law of contract, whereby the contractual duties are primarily upheld by courts as they represent the freedoms between individuals concerning business dealings. In addition, the elements of a valid contract are so tightly defined that to override them would make a mockery of an individual's right to deal. If all these elements are in the contract along with good faith then the contract is complete and must be honored or a breach of contract law may be present. Good faith is present within all types of contracts whereby it refers to the honest intent to act without taking an unfair advantage over the other person within the contract. Therefore, the only method to discharge a contract is through actions in breach, frustration, fraud etc. In respect to business dealings between companies, these principles are stricter because it is assumed that the bargaining power is equal as they are both knowledgeable in the workings of contracts. In Insurance law, the aim to ensure that contracts between parties are upheld and the courts will always find an avenue to ensure that a contract is upheld. In respect to material fact, this rule is stricter because the contract is complete and performance has occurred. Material fact that there has been an occurrence that the insuree can bring forth a claim on the insurance must be overt, within the contract and based upon good faith (i.e. honest). In English law a different approach is taken than within US law; whereby material fact illustrating a point where the contract is completed will be upheld in the UK. On the other hand, in US law the notion of good faith is important and if there is any fraud then the contract is null and void. Therefore, material fact has to be based on the intentions of the actions that lead to the insurance claim.1 This difference in approaches to contracts in US and the UK will illustrate how the UK will uphold claims even if questionable on the strict guidelines of the contract and material fact; whereas the US relies more on the concept of good faith and how this applies to material fact. The basis of Hansen Bancorp Inc et al v US2 is that the Court of Federal Claims had erred in its judgement and the breach of contract by the US government was total therefore the appellants of the Hanson Company were entitled to restitution on all counts. This decision stems around the question whether there has been a total breach of contract, if there has been a total breach of contract restitution is available; however without total breach this remedy is not available. The court decided there was a total breach because the US government had come to a contract and Hanson had committed its resources by fulfilling its duties; however the US government had failed to complete its obligations therefore fulfilling the criteria of a total breach of contractual obligation. This decision is primarily an exercise in the power of the contract and its adherence, which cannot be avoided even if the breaching party is the government. The case of Hansen Bancorp heavily relies on the adherence of the contract and contract law; whereby once the parties started to act on the contract then it is only fair that the other party follows through with their contractual obligations. This case does not fudge along the lines of what may not constitute total breach of the contract. Rather the courts take a very logical and straightforward approach considering each part of the dealing to ensure that a total breach has occurred. The court identifies that a breach is an act or failure to act that impedes the fulfillment of the contract by one of the parties, where the other party has fulfilled their obligations or all the obligations they are able to prior to action by the other party. This approach ensures that the original contract is the most important factor in determining a breach and if the actions of a party are obviously impeding the contract then there is a breach of contract, i.e. by not fulfilling their contractual obligations there is a total breach. Therefore, the original good faith put into creating the original contract is more important than whether there was one complete contract or two separate contracts. If there was an original deal and intention cemented with good faith from the beginning and an act impedes the whole project then the good faith is breached; hence, the contract is breached. In the case of insurance law in the US this is how material fact is determined, because if the material fact is based upon actions and there is good faith then the insurance company must pay out the insuree. However, if there is an act at the beginning of the insurance contract or causing the material fact that is not based upon good faith then there is no obligation to pay out. In the UK there has to be extreme breaches of fraud laws for a contract to be upheld, not just a mere breach of good faith. Stocznia Gdanska SA v Latvian Shipping Co3 is a case that deals with an appeal dealing with the validity of restitution; however, this case's argument is based upon an argument that there was a total failure of consideration. However, consideration the House of Lords argued was defined from the actions of the shipbuilders, i.e. had they acted on the contract and were funds expended The contract was for design, construction and delivery and as the shipbuilders had acted on this has consideration been fulfilled In this case the House of Lords argued yes because it is was not just a contract of the mere sale of a ship, but the design and construction; whereby once this design and construction has been initiated then there can be no total failure of consideration. In the case of Stocznia Gdanska SA, when considering whether there has been a breach of the contract by the failure of total consideration, the courts rather than specifically considering the contract words is focuses on the intent and actions of the parties in conjunction with the written contract. In the purposes of justice, the court considered the whole contract, its wording and the actions of each of the parties; therefore resulting in a decision by the court that is balanced and ensuring that one party is not penalized because the other party does not want to fulfill its obligations. Whereby the party claiming that there is total failure of consideration purports that there is no evidence of total consideration because this party has not acted or has be put at a detriment in respect to the contract. The court rather considered the actions of the other party, the shipbuilders, and determined if there was any consideration on their part and if there is then there cannot be a total failure of consideration. Therefore, this case illustrates the English courts adherence to contracts over the possibility that the requirements are not available. If one takes this thinking and applies it to the problem at hand where a contract is performed, it is highly unlikely the courts will overturn it because it will affect certainty of contracts. Yet there are cases of injustices and it is necessary for the courts to become involved in insurance cases and go against material fact, such as in the case of extreme fraud and illegality because these cases are going against equitable and statutory principles. Insurance is an agreement for one party to pay a repayable to sum to another, once an occurrence that has listed has been properly completed then it is binding the party to pay this sum of money, i.e. extend protection to the other party. In other words, as with a contract to exchange goods etc once it has been completed and has all valid elements the court will uphold the validity of the contract and its performance; therefore to have valid insurance presupposes that a valid contract is in place, which is at the heart of this discussion. There is one exception, other than the lack of a valid contract, which is the presence of fraudulent information being forwarded to the insurer. This means that if the information that the insurer is given wrong and the person who is lending the money knows this then it is fraud and will fulfill the fraud exception to stop the credit note being held valid. UK law does not provide any specific statute to confirm this but is enshrined within common-law principles. This exception is very similar to the notion of utmost good faith in insurance law in principle the use of it is very limited therefore limiting the working of justice, i.e. if there is a legal principle that is rarely or never used makes it null and void. This may seem to be counterproductive to the other approaches to fraudulent contracts; however, it seems to be indicative of the UK's approach of upholding valid contracts over the invoking justice. The problem with just relying on the fraud exception is that it does not deal with other aspects of illegal contracts that contain all three of the requisite requirements of a valid contract. In addition, how can a valid insurance contract be justly upheld if it breaches a statutory or common law principle The answer is that it cannot and to uphold it makes a mockery of the legal system and contract law because injustice is deemed to be okay it someone contracts it to be so. The following section will consider the notion of good faith, which this essay would argue should be another element of good faith linking it with the principles of illegality. Good faith is basic to a valid contract in most jurisdictions; however, in English law it has been greatly ignored, except in insurance law where it has been put in statute but phrased as utmost good faith. Therefore, this discussion will briefly go over the principle of good faith in insurance law and then illustrate how in other types of contracts it is not used, but in the US, it is a basic principle, as the next section's case study will illustrate. Then it will consider illegality and illustrate if the principle of good faith was utilized then this would be an exception to the validity of an insurance agreement. Utmost good faith refers specifically to insurance law; whereby the insured must disclose all the material facts, otherwise the insured can vitiate the contract. The concept of good faith is present within all types of contracts whereby it refers to the honest intent to act without taking an unfair advantage over the other person within the contract. In the area of insurance law, it is essential for the insuree to notify the insurer of all applicable information because this will effect if the policy can be made and the amount of the policy. This is because the insuree is in the position of power as they know all the information and their duty is to disclose it. If one looks at the relevant notion of a valid contract, if the elements of a valid contract are not present then the contract is void. This principle relies on validity and if a contract is illegal should it not means that any thing that is received from the contract is rescinded, i.e. the valid insurance. The first types of illegality that will be considered are contracts that are immoral, i.e. if the contract is known to be for an immoral purpose, it is void.4 Contracts that are for illegal purposes are also held to be void5. Any contract that is contrary to a statute is also void6; however the case of St John Shipping Corporation v Joseph Rank Ltd7 held that a court should not hold a contract is prohibited by statute unless this intention is clear. The case of Taylor v Bail8 held that any contract that is tainted by an illegal purpose is not enforceable. Also in the interests of justice, an innocent party can claim restitution9. Finally the case of Tinsley v Milligan10 holds that in property law illegality can only discharge an equitable interest where this illegality must be relied upon to prove the claim. Therefore, there are many held instances of illegality in contracts and the question is why do these principles apply distinctly to and override material fact within insurance law The answer in US law is simply that although a material fact which insurance covers has occurred11, it is still invalid because the contract is not based upon good faith; therefore, the insurance contract is not valid. Case Study Fraud Exception - UK & US: The given approach to fraud exception was defined by Lord Denning in United City Merchants v Royal Bank of Canada12 as that defined in the US Case Sztejn v Henry Schroder Banking Corp13: To this general statement of principle [of independence], ... there is one exception: that is, where the seller, for the purpose of drawing on the credit, fraudulently presents to the confirming bank documents that contain, expressly or by implication, material representations of fact that to his knowledge are untrue. Although there does not appear among English authorities any case in which this exception has been applied, it is well established in the American cases of which the leading or "landmark" is Sztejn v J Henry Schroder Banking Corp (1941) 31 N.Y.S. 2d 631.14 Yet, as previously mentioned the courts take a non-interference approach to insurance and letters of credit, in order to interfere the fraud must reach a specified burden of proof and must actually involve beneficiary fraud. The standard of proof is very high where there must be clear and unequivocal proof that fraud has been committed. The case of RD Harbottle v Natwest15 defines this burden of proof as: Except possibly in clear cases of fraud of which the banks have notice, courts will leave the merchants to settle their disputes under the contracts by litigation or arbitration as available to them or stipulated in the contracts. ... Otherwise, trust in international commerce could be irreparably damaged. Therefore, as with the exploration of the UK's approach to upholding the certainty of contracts the courts take a very enlightened principle and hinder it with such a high burden of proof that it makes it unusable. In addition, the courts have added the actual necessity for there to be beneficiary fraud, which means that the fraud has to be committed by the beneficiary of the credit note or insurance payout. Therefore, if some fraud was involved by at the hands of a third party the creditor has to bear the weight of this fraud even if the fraud would have met the high standard of proof. This has been upheld in the United City Merchants Case. Therefore this seems to prove that the UK's adherence to contract certainty far outweighs the basic principles of justice, which leads one to believe that notion of utmost good faith is an exception to the rule of upholding the certainty of contract, especially in respect to contracts that are made by companies. This was stresses in the judgment of the RD Harbottle Case when the decision of imposing a high burden of proof was being justified in the nature of commercial certainty: Otherwise, trust in international commerce could be irreparably damaged. The USA, on the other hand, champions the fraud exception rule as to uphold fraudulent acts breaches the basic precepts of justice of a valid contract. The USA has enshrined this rule in statute, as well as has extended to types of fraud. The Sztejn Case as in the UK is the key case dealing with fraud exception; however, it is not limited by a high burden of proof. It also is not limited to intentional and unequivocal fraud, i.e. it includes constructive fraud and egregarious fraud, but most interestingly the USA approach has a flexible standard that is indicative of the USA's adherence to justice in contracts whether on party is a company or not. This flexible standard is confirmed in the case of United Bank Ltd v Cambridge Sporting Goods Corp16 : It should be noted that the drafters of section 5-114, in their attempt to codify the Sztejn case and in utilizing the term "fraud in the transaction", have eschewed a dogmatic approach and adopted a flexible standard to be applied as the circumstances of a particular situation mandate. It can be difficult to draw a precise line between cases involving breach of warranty (or a difference of opinion as to the quality of goods) and outright fraudulent practice on the part of the seller. Therefore this leads on to the conclusion that the approach of the UK is too entrenched in the belief that certainty in commercial contracts outweighs justice, which has created a lopsided and unfair system concerning letters of credit and insurance; especially when the fraud exception is based upon principles that promote justice as in the USA. In the interests of justice, illegality should be a distinct exception; however, the court reasoning with respect to the fraud exception does not seem to allow for this route of justice. It almost seems that justice contrary to the basic precept of upholding contracts, yet this is not true for other jurisdictions such as the USA. It almost seems that UK courts do not want to be involved in dismantling valid contracts, yet as this argument assumes how can there be a valid contract without good faith. The answer is there cannot be, yet as the UK courts rely on laissez faire principles when it comes to contract law, i.e. as little interference in valid contracts as possible they seem to refuse to become involved unless there is statute such as in respect to utmost good faith insurance law. Therefore, in order for there to be justice there needs to the introduction through statute to ensure that there is an illegality exception and fraud exception to the principle of the material fact; otherwise the law surrounding illegal and fraudulent contracts is a mockery. Bibliography: J. Beatson, 1998, Anson's Law of Contract (27th Edition), Oxford, Oxford University Press Bender, 1988, A feminist's primer on feminist theory and tort, 38 J Leg Ed 3 Michael Bridge, The International Sale of Goods - Law and Practice, 1999, Oxford, Oxford University Press The Buyer, 1999(a), On the Passing of Property, The Buyer 21.10(1) The Buyer, 1999(b), Export and Import Licenses, The Buyer 21.2(7) David Kelly, Ann Holmes & Ruth Hayward (2002) Business Law 4th Edition, London, Cavendish Lunney & Oliphant, 2000, Tort Law: Text & Materials, Oxford Uni Press G. McMeel, 2002, Book Review of The International Sale of Goods - Law and Practice, CLWR 31.1(103) J. Poole, 2000, Casebook on Contract (4th Edition), London, Blackstone Prosser & Keeton, 1999, The law of Tort 5th Edition, West Law S. Singleton, 1999, In Focus - Passing of Title and Risk, CLT 22.10(9) W. Tetley, (to be published 2007) Marine Cargo Claims 4th Edition, Chapter 7: Sale of Goods - The Passing of Title and Risk - A Resume, can be found at http://tetley.law.mcgill.ca/maritime/ch7.pdf Uff, J, 2002, Construction Law (8th Edition) London, Sweet & Maxwell Stephen Weatherill (2000) Cases & Materials on EC Law (5th Ed), London, Blackstone Press F. White & R. Bradgate, 1993, Bills of Lading - the Carriage of Goods at Sea Act 1992 may face a stormy future, LSG 90(23) Read More